Bitcoin & Crypto | Monetary Policy & Inflation | US
Will Inflation Worries Doom the Bitcoin Rally?
- By Dalvir Mandara and Bilal Hafeez
- 5 min read
Summary
Trading View (next 2-4 weeks): We like to be slightly bearish bitcoin.
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Summary
Trading View (next 2-4 weeks): We like to be slightly bearish bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
Macro
- March US CPI showed no incremental progress on disinflation (a smaller decrease in used car prices offset a slower increase in shelter costs).
- Higher-than-expected PMI data indicates business activity in the US accelerated in April.
- We agree with markets pricing an 85% chance of a 25bp hike at the 3 May FOMC meeting.
- We think the probability of a full-blown banking crisis is low.
- The probability of a recession within the next 12 months remains high.
- Overall, the macro backdrop is still bearish.
On-Chain/Flow Signals
- Our on-chain signals are split this week with two bullish, two bearish, and two neutral.
- The on-chain signal is neutral overall.
Overall View
- With the macro backdrop bearish, and our on-chain/flow signals neutral, our overall view is slightly bearish bitcoin (Chart 1).
Macro: Data Points to Higher for Longer Interest Rates
Inflation trends remain stubborn. March CPI showed no incremental progress on disinflation as a smaller decrease in used car prices offset a slower increase in shelter costs. Furthermore, with unemployment at 50-year lows and strong demand growth, core inflation remains unresponsive to lower energy prices. This suggests a strong increase in energy prices could lead to a generalised increase in inflation, particularly given the recent cuts in oil production announced by OPEC+.
Consumption growth could remain above trend. We think consumption could stay strong as income and spending dynamics are likely to keep inflation within its current range. One risk to this view is a credit crunch crimping spending, though we consider this unlikely.
Business activity accelerates in the US. A higher-than-expected reading for the S&P Global Flash Composite PMI (53.5 vs 52.8 expected) suggests business activity has regained momentum and raises the possibility that the Fed hiking cycle will continue past 3 May.
We agree with markets pricing an 85% chance of a 25bp hike at the 3 May FOMC meeting but disagree with the c. 40bps of cuts priced in over the remainder of the year.
Overall, the data continues to point to higher for longer interest rates. The macro backdrop is bearish for bitcoin.
On-Chain/Flow: ETF Outflows Resume
Two give a bullish signal this week:
- Futures activity: Perpetual funding rates are still positive.
- HODLer behaviour: Most (67%) of the coin supply has not moved in at least a year.
Two metrics give a bearish signal:
- Institutional demand: ETF outflows resume.
- Liquidity demand: A bias exists for exchange inflows.
The remaining two metrics give a neutral signal:
- P&L of investors: The profitability of the coin supply has dropped recently, but realised profits still dominate on chain.
- Mining activity: The hash rate sets new all-time highs, but miner revenues are down.
On balance, on-chain/flow metrics are giving a neutral signal. Here are the details of each metric (with explanations in the Appendix).
Institutional Demand: Bearish Bitcoin
Our preferred metric to track institutional demand is flows into bitcoin ETFs. Outflows, though small in magnitude, have returned. Around $11mn left the Bitcoin ETFs we track over the past 5 days (Chart 2). This is bearish bitcoin.
Demand for Liquidity and Exchange Activity: Bearish Bitcoin
On exchange flows:
- Short term, a bias for inflows to exchanges exists. Net c. 24,000 coins entered exchanges over the past two weeks (Chart 3).
- Longer term, the 30-day change in the exchange balance has re-entered positive territory (Chart 4).
Overall, the bias for exchange inflows is bearish for bitcoin as it suggests investors want to keep their coins in a liquid capacity where they are easier to sell.
Futures Activity: Bullish Bitcoin
On futures markets:
- Futures open interest ($8.3bn), a good measure of investor interest, has been decreasing since peaking at $9.8bn on 13 April, though it is up 3% MoM (Chart 5).
- Perpetual funding rates have, on average, remained positive (Chart 6). This means traders are paying a premium to keep open long positions, which is bullish for bitcoin. However, the magnitude of the positive funding rate has been decreasing recently.
Together, this is bullish bitcoin.
HODLers: Bullish Bitcoin
On HODLer metrics:
- The 30-day moving average of the coin days destroyed (CDD) metric is down -17% MoM (Chart 7).
- The 30-day moving average of the 1y+ revived supply metric is down -18% MoM (Chart 8).
- The 1y+ vintage dominates around 67% of the coin supply now (Chart 9).
Overall, we still see the strong conviction to hold by most of the coin supply as a bullish signal for bitcoin.
Investor Profit and Loss: Neutral Bitcoin
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) sits at 70%, down -4pp MoM (Chart 10).
- Net unrealised profit/loss (NUPL) is 0.29 (29% of market cap, flat MoM, Chart 11). The metric means the supply is in a net profit position (NUPL > 0), with market cap exceeding realised cap.
- Year to date, the spent output profit ratio (SOPR) has spent 64% of time above one (realised profits, Chart 12). Looking at the last month alone, SOPR has been above one for 83% of the time.
The profitability of the coin supply has taken a hit recently, but the supply remains in an (unrealised) net profit position (NUPL > 0) and realised profits on chain (SOPR > 1) dominate year to date. Overall, this is neutral for bitcoin.
Mining Activity: Neutral Bitcoin
The hash rate continues setting new all-time highs and is up +2% MoM (Chart 13). Meanwhile, miner revenues are down -4% MoM (Chart 14). Together, this is neutral bitcoin.
Appendix
Institutional Demand
Perhaps the largest institutional vehicle for bitcoin is the Grayscale Trust, with over $27bn in assets. It invests solely in BTC, and so many investors, notably institutional, who cannot hold BTC directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to BTC prices, it may imply ‘excess’ demand from institutions, but ‘excess’ supply if it trades at a discount. Alternatively, the discount may suggest investors have found other ways to get exposure to BTC, whether through ETFs or directly holding BTC. We therefore focus on how the discount has changed in recent months to gauge investor interest. Alternatively, investors may be using other vehicles to get exposure such as ETFs or holding BTC directly. We put more weight on BTC flows than the Grayscale premium.
Liquidity Demand
Another measure of cryptocurrency bullishness is whether investors are willing to hold it in illiquid form (e.g., a private wallet) or prefer a liquid form (e.g., on an exchange). The former would suggest investors are bullish, as they are comfortable with being unable to sell easily. Conversely, holding it in liquid form would suggest investors are bearish, as they prefer being able to sell easily.
Therefore, large flows onto crypto exchanges would suggest investors want to convert their holdings to a more liquid form, implying more bearishness.
Futures Activity
We track the growing market of bitcoin futures. Open interest – the sum of long and short contracts – is a good measure of investor interest.
Perpetual funding rates reveal the directional bias of investors. Exchanges set funding rates to prevent a lasting divergence in the price of the futures contract and the underlying since perpetual contracts have no expiry date so never settle in the traditional sense. Consequently, we can interpret funding rates as the cost of holding bitcoin via perpetual futures. Positive funding rates imply longs pay shorts and vice versa. We use it as a proxy for trader sentiment since a positive funding rate implies traders are paying a premium to keep open long positions.
HODLers
In our introductory bitcoin flow framework, we explained ‘HODLers’ and ‘HODLing.’ HODLing refers to buy-and-hold strategies in the context of bitcoin and other cryptocurrencies. Those who HODL for extended periods are die-hard adherents.
We can categorise HODLers by the length of time they have held BTC. We define long-term or staunch HODLers as those who bought BTC five or more years ago and have held it ever since, medium-term HODLers as those who bought 6-12 months ago, and short-term HODLers as those who bought 3-6 months ago.
The coin days destroyed (CDD) metric is defined as the number of coins in a transaction multiplied by the number of days since the coins were last spent. So, increasing CDD suggests older coins are being spent (more coin days are destroyed) and vice-versa.
Profit and Loss
The percent supply in profit (PSIP). This tracks the share of circulating BTC supply in profit. That is the percentage of circulating BTC whose current price is higher than when it was last transacted (movement).
Net unrealized profit and loss (NUPL). This is the ratio of unrealised profits over total market capitalisation. While PSIP just focuses on whether BTC coins are in profit or not, the NUPL focuses on the size of profits. So, we could have a situation where the PSIP is low – that is, a low share of supply is in profit – but the NUPL could be high if the size of those profits is large.
Spent output profit ratio (SOPR). While PSIP and NUPL focus on unrealised profits or mark-to-market, this measure focuses on realised profits. SOPR is the realised value of a transaction divided by the value at initiation (or creation) – more simply, price sold divided by price paid. If SOPR is above one, investors in aggregate have realised profits, while below one means they have realised losses. In broad uptrends, SOPR spends a significant amount of time above one, whereas the opposite is true for broad downtrends.
When SOPR is rising, sellers are increasingly realising profits. The opposite is true when it is falling. A price rally with a flatter SOPR trend indicates investors are not yet realising their profits with the rally. The reluctance of investors to sell and realise a profit may be because they believe the price will increase further, which would be bullish. At the same time, more profit taking could precede a correction. Typically, buying as SOPR moves around one during bullish periods has proven to be a profitable strategy.
Mining Activity
Computing power is central to the crypto market. Miners use advanced computing hardware to solve complex problems that confirm BTC (and other coins) transactions on the public ledger or blockchain. The miners are rewarded with new coins for their efforts. A measure of the complexity of the problems and so the computing performance required to solve them is the hash rate. The higher this rate, the more computing performance is needed to maintain the blockchain. The rate can fluctuate depending on demand for crypto.